Managing your 401(k) might seem like a small fish in a big sea of decisions while considering job changes, but it’s actually a whale of a task. 

A 401(k) rollover involves transferring funds from your current 401(k) plan to a new 401(k) plan or an IRA. The IRS allows you sixty days from the date you receive a distribution from your 401K or retirement plan to complete the rollover to another retirement plan or IRA.

Rolling over your 401(k) offers several key benefits, primarily consolidating multiple retirement accounts into one. It’s also a brief window to transition your 401(k) balance from the tax-deferred into the tax-free bucket.

Although sixty days seems like adequate time, and in most cases, it’s plenty, it does go by relatively quickly, especially given the heap of other life, job, and routine changes likely to be co-occurring. 

Rather than leaving it as a burning “to do” list item in the back of your head, here’s the best way to approach your 401(k) rollovers. Let’s dive into the best practices for rolling over your 401(k) and ensuring your retirement nest egg grows uninterrupted. 

Understanding the Basics: What Actually Is a 401(k) Rollover?

A 401(k) rollover is a process where you transfer the funds from your existing 401(k) retirement account to another retirement account, usually an Individual Retirement Account (IRA) or another 401(k) plan. 

This transfer typically occurs when you change jobs or retire, allowing you to consolidate your retirement savings and maintain the tax-deferred status of your funds.

It seems self-explanatory enough, but it gets more complex.

There are two primary methods for rollovers: direct and indirect.

In a direct rollover, the funds are transferred directly from your old 401(k) account to your new IRA or 401(k) plan without you ever touching the money.

This straightforward method minimizes the risk of tax penalties, as the money moves directly from one retirement account to another, maintaining its tax-deferred status.

On the other hand, with an indirect rollover, you receive the funds from your 401(k) account and are responsible for depositing them into your new retirement account within 60 days. 

While this gives you temporary access to the funds, it comes with risks. If you don't complete the transfer within the 60-day window, the distribution becomes taxable and could incur additional penalties if you are under 59½. 

Additionally, your former employer will withhold 20% of the distribution for taxes, which you must replace from other sources to avoid taxes and penalties on that amount.

So, it’s not exactly the cleanest of maneuvers if you want to access your 401(k) funds in the intermediary period. 

If rolling over a 401(k) seems like an issue of formality, well, it is. 

However, there are specific strategies high earners often do in a relatively brief window, most of which are advisable to do with a financial planner. 

A direct rollover is the best option to roll over your 401(k) to your new gig, as it ensures your funds remain tax-deferred. 

However, if you’re considering an indirect rollover (like what is described below), make sure you can cover the 20% tax withholding from other funds to avoid penalties.

Managing Your Old 401(k) Assets: The Basics

Remember that these funds are yours and permanently not tied to your former employer or the retirement plan provider.

This means you’ve got options. 

For starters, you could just keep your 401(k) with your previous employer's plan, which allows your investments to continue growing based on your existing allocations unless you decide to adjust them. 

Though it may involve higher administrative fees and possibly limited investment choices compared to other options, this is the most straightforward approach.

Secondly, if such transfers are permitted, you might consider transferring your old 401(k) into your new employer’s plan. Consolidating everything under one plan could simplify your financial landscape.

However, similar to the first option, this could come with limited investment choices and potential fees.

The third option is to cash out your 401(k), which is generally the least advisable because it can trigger significant tax liabilities and penalties, especially if you are under 59 and a half. 

This move converts your deferred retirement savings into immediate taxable income, potentially costing you more in the long run.

Lastly, rolling over your old 401(k) into an Individual Retirement Account (IRA) is often recommended because an IRA typically offers lower fees and a more comprehensive range of investment opportunities. 

This option allows for greater flexibility and helps consolidate your retirement funds as you transition between jobs.

When and Why to Rollover your 401(k)

Rolling over your 401(k) during a job change keeps you in control over your retirement savings and allows you to consolidate multiple retirement accounts.

This consolidation can reduce paperwork and allow you to focus on maintaining a coherent investment strategy. Plus, you can rebalance your portfolio across all your assets in one location. 

This changing period is also an excellent time to reassess your 401(k) fee structure. As the industry has grown increasingly competitive, your old 401(k) accounts may have higher fees or limited investment options. 

Steps to Successfully Roll Over Your 401(k)

Start by evaluating your current 401(k) plan. 

Though you aren’t required to roll over your 401(k) when you leave a job, it’s generally advisable. If you choose not to roll over your 401(k) for whatever reason, be mindful of the fees, complexity, and investment limitations that may arise. This is one of those times when consulting a financial planner for your unique situation tends to pay off big time. 

When evaluating your current 401(k) plan, review the fees, investment options, and potential penalties. This evaluation helps determine the baseline for whether rolling over is advantageous​.

Next, compare apples to apples with your new 401(k) plan. 

You should also consider whether to roll over into a traditional or Roth IRA or into a new employer’s 401(k) plan, considering factors such as investment choices, fees, and the flexibility of each option​– we’ll get into this more below.

Finally, it’s time to initiate the rollover process. 

If you’re going to rollover into the new company’s 401(k), It’s advisable to request a direct rollover. This way, funds are transferred directly to the new account to avoid tax withholding and penalties.

However, you can also do an indirect rollover– just ensure you deposit the funds into the new account within 60 days to avoid taxes and penalties​.

Roth Conversions During a Rollover

This seems like the financial planner equivalent of a Top Gun jet maneuver, and while it may not be as flashy as an F-14 Tomcat, it could set you up for a much comfier retirement– which, in my book, is way cooler. 

Converting a traditional 401(k) to a Roth IRA during a rollover can be a smart move if you expect a higher tax rate in retirement, anticipate significant income growth, or are making other estate planning considerations. 

This involves paying taxes on the converted amount now, allowing the funds to grow tax-free afterward. The cherry on the cake, you get tax-free withdrawals when you retire with no Required Minimum Distributions (RMDs)! 

If you have the flexibility, consider rolling over your 401(k) and converting to a Roth in a year when your taxable income is lower. This could be a year when you’ve taken a sabbatical, experienced a career transition with lower earnings, or have significant deductions. 

The amount you convert from your 401(k) to a Roth IRA will be taxed as ordinary income. This rate depends on your total income for the year and your tax bracket. 

Remember that the amount you convert is also considered ordinary income, which may raise your tax bracket. 

For example, if you convert $100,000 from a 401(k) to a Roth IRA and your total income for the year, including the conversion, places you in the 35% tax bracket, you will pay 35% tax on the $100,000 converted.

If, serendipitously, you can do the conversion on a no-income sabbatical year, you’d be taxed at 22% and lower, as different marginal tax rates apply for the total $100,000. 

FAQs & Common 401(k) Rollover Predicaments

How is an IRA different?

IRAs typically offer a broader range of investment options than 401(k) plans, including stocks, bonds, mutual funds, ETFs, etc. You can use the rollover to diversify your portfolio, allowing for a more sophisticated asset allocation strategy. 

Note that there are two different types of IRAs:

A traditional IRA is tax-deferred. A rollover from a 401(k) to a traditional IRA is typically a tax-free transaction since both accounts are tax-deferred. 

This means you don’t pay taxes on the funds when you roll them over. The funds will continue to grow tax-deferred, and you will pay taxes on distributions when you take them in retirement.

As described above, a Roth IRA is an after-tax account. Rolling over from a 401(k) to a Roth IRA is taxable. You will need to pay taxes on the amount rolled over in the year of the rollover.

Once in the Roth IRA, the funds will grow tax-free, and qualified distributions in retirement are also tax-free.

Before rolling over, review your current 401(k) fee structure and compare it with potential IRAs; folks with substantial balances can save significantly over time by minimizing fees, as IRAs tend to have lower fees. 

The less you pay in fees means more of your money is left to grow, which can be a sizeable difference come retirement time. Given the larger account balance, look for low-cost IRAs and consider negotiating fees.

Notably, IRAs have broader investment options, and a financial planner can help you make sure your retirement accounts align with your investment strategy. 

Consolidating your retirement accounts can also simplify taking required minimum distributions (RMDs) once you reach age 72. Instead of managing RMDs from multiple accounts, you can streamline your withdrawals from a single account, making the process more manageable and less stressful.

What if I have company stock in my 401(k)? 

When you take a lump-sum distribution from your 401(k) that includes company stock in a rollover, you can transfer it directly to a taxable brokerage account instead of rolling it into an IRA. 

The stock's cost basis (original purchase price) is taxed as ordinary income at the time of distribution.

You might benefit from Net Unrealized Appreciation (NUA) rules, which essentially say that rolling over the employer stock to a brokerage account instead of an IRA can take advantage of long-term capital gains tax rates on the stock’s appreciation rather than ordinary income tax rates. 

For example, let’s say your cost basis for the company stock in your 401(k) is $10,000 and has a current market value of $50,000. If you roll over the stock to a brokerage account, you will pay ordinary income tax on the $10,000 cost basis at the time of distribution. 

When you sell the stock, the $40,000 appreciation (NUA) will be taxed at the long-term capital gains rate.

Alternatively, you could sell the stock and maintain the tax-deferred status just like the rest of the 401(k). 

How long does it take?

The typical rollover time frame is about one to two weeks, accounting for processing times at both the sending and receiving institutions. Still, it’s worth planning for up to four weeks for the entire rollover process to ensure everything is correct. 

Can I roll over a portion of my 401(k)?

In theory, partial rollovers are allowed, enabling you to roll over only a part of your 401(k) while leaving the rest in the original account.

What happens if I miss the 60-day rollover window?

If you miss the 60-day window in an indirect rollover, the amount is treated as a distribution, subject to taxes and potential early withdrawal penalties.

This means the distribution is subject to ordinary income tax, and if you’re under 59½ years old, you may also face a 10% early withdrawal penalty.

Still, you have some recourse available. The IRS specifies that there are certain circumstances under which you can request an extension or relief.

You may qualify for an automatic waiver if the financial institution received the funds within sixty days, but the deposit to the new retirement plan was delayed due to an error by the financial institution. See IRS Revenue Procedure 2003-16 for more details. 

If you missed the deadline due to events beyond your control (e.g., severe illness, a family death, postal error), you can use a self-certification process to claim that you qualify for a waiver of the 60-day rule. 

You must provide a certification to the plan administrator or the IRA trustee, and if the IRS audits you, you must be able to prove the conditions were met. See IRS Revenue Procedure 2016-47 for more details. 

As a worst-case scenario, if neither of the above applies, you could apply for a private letter ruling from the IRS. This process involves a formal request and fee payment, and the IRS will review your case and decide if relief is warranted.

Good luck. 401(k) rollovers are standard practice for financial planners, and they can help you avoid the complexities of the process. 

What are the benefits of a mega backdoor Roth IRA rollover?

Top earners can use after-tax contributions to a 401(k) to perform a mega backdoor Roth IRA conversion, allowing a sizable new allocation of funds to grow tax-free.

In 2023, Regular Roth IRA contributions were limited to $6,500, with an increased limit of $7,500 for those 50 or older.

The Mega Backdoor Roth IRA allows for significantly higher contributions. For 2024, the total contribution limit to a 401(k), which includes pre-tax, Roth, employer match, and after-tax non-Roth contributions, can reach up to $69,000 (or $73,500 if you are 50 or older).

To utilize the Mega Backdoor Roth strategy, contributions must be made to your 401(k) while you are still employed and before initiating the rollover process. The rollover itself does not allow for new contributions.

After contributing to your 401(k), you can roll over the after-tax portion to a Roth IRA during the rollover period. This rollover can be done while employed (if your plan allows in-service distributions) or after leaving your job.

Making Cents of 401(k) Rollovers

Well, there you have it– smooth sailing through the “what ifs” of 401(k) rollovers. 

With a clear understanding of the process and careful planning, you can use this rare opportunity to consolidate your retirement accounts, align your financial planning focus, and accomplish some sage tax diversification. 

While education is power, you wouldn’t necessarily attempt a backflip after reading about it on the first try. It’s worth consulting with a financial planner to, at the very least, help you evaluate your financial situation and ensure your plans for a sunny and stress-free retirement won’t be unhinged by administrative missteps.